Aspen Insurance Holdings Ltd (AHL) 2012 Q4 法說會逐字稿

Hello, and welcome to the fourth quarter 2012 earnings conference call.

(Operator Instructions)

I would now like to turn the conference over to Ms. Calaiaro. You may begin your conference.

The presenters on today's call are Chris O'Kane, Chief Executive Officer, and John Worth, Chief Financial Officer of Aspen Insurance Holdings. Last night, we issued our press release announcing Aspen's financial results for the quarter and year ended December 31, 2012. This press release, as well as corresponding supplementary financial information, can be found on our website at www.aspen.co.

This presentation contains, and Aspen may make from time to time, written or oral forward-looking statements within the meaning under and pursuant to the Safe Harbor provisions of the US federal securities laws. All forward-looking statements will have a number of assumptions concerning future events that are subject to a number of uncertainties and other factors. For a more detailed description of these uncertainties and other factors, please see the risk factor section in Aspen's annual report on Form 10-K filed with the SEC and on our website.

This presentation contains non-GAAP financial measures, which we believe are meaningful in evaluating the Company's performance. For a detailed disclosure on non-GAAP financials, please refer to the supplementary financial data posted on Aspen's website. I will now turn the call over to Chris O'Kane.

In 2012, Aspen grew book value per share more than 6% to $40.65, or if you add back dividends, book value per share grew more than 8%. We delivered an operating ROE of 8.5%. I believe we can be pleased with an operating ROE of 8.5% in a year such as 2012, characterized by only modest increases in underwriting pricing, muted investment returns, and a $25 billion or more loss event, Superstorm Sandy. Pleased I would say, but not satisfied. Never satisfied. It is for this reason that I want to break with normal protocol on these calls to tell you straight away about how we want to address profitability, improve ROE, and enhance book value per share.

The insurance pricing environment is showing areas of improvement, but this hardening is not across all markets and all geographies. We continue to operate in the low interest rate environment, and like many others, do not believe that fixed income investment opportunities will improve materially in the medium term. Also, many global economies have yet not shown signs of returning to meaningful growth. Given these environmental factors, we have heightened our focus on improving shareholder value by addressing the elements of the business that are more directly under our control.

There are two measures of shareholder value in which we focus most, operating ROE, and growth in book value per share. We have three main levers we will use to drive an increase in ROE. One, a significantly increased emphasis on profitability and risk profile of each of our major lines of business. Two, insuring that the capital and equity we hold are appropriately sized, given the risks in our business. Three, optimizing investment income by responding rapidly to the changing dynamics of the global markets. Growth in book value per share is also driven by these three levers, but in addition, will respond to improvements in the total return of our investment portfolio and the scale of our share repurchase program.

Let me start by explaining what I mean by an increased emphasis on profitability and risk profile. We've always had a [disciplined] approach to assessing the profitability of products and distribution channels. For example, over the last three years, we've withdrawn from or scaled down our underwriting of structured reinsurance, of UK motor reinsurance, of new or contracted liability insurance, also prime re-pharmaceuticals products liability. In addition, we've reduced our exposure to casual reinsurance by 36% from its peak. But the continuing difficult pricing environment in many lines, low investment returns, and a weak global economy have led us to re-challenge the acceptability of returns, risk, and volatility for each of our major product lines.

John Worth's arrival in November has brought a fresh perspective to this assessment and reinforced the discipline required to release capital from those lines of business that have lower-than-average risk adjusted returns or earnings volatility that is not adequately compensated for by higher returns. Capital so released will be added to our share repurchase program unless exceptional opportunities to redeploy elsewhere should emerge. I am pleased to say that the overwhelming majority of our product lines have been revalidated by this process.

However, we have concluded that the earnings from our US property insurance portfolio are excessively volatile as a result of still-inadequate original rates for cat-exposed primary policies, and due to the expensive reinsurance costs that leave insufficient margin for expenses and non-catastrophic additional attritional claims. Therefore, we are beginning a significant and controlled reduction of our wind and quake exposure within our US property insurance account, which we expect to result in the release of over $140 million of capital within the next two years. This we will add to our share buyback program unless very compelling other opportunities emerge. We're highly encouraged by the excellent progress being made by our US insurance operations, and we will continue to underwrite all of the current US lines of business, with the significant change that our appetite for highly-catastrophe exposed property insurance will be sharply reduced.

The second lever to drive up ROE and BVPS is right-sizing our capital and equity. We have recently completed a major review of our risk capital requirements, and concluded that we currently hold excess capital of approximately $250 million, not including the capital to be released by changes to our US property insurance account. We have also concluded that, given normal loss experience, we expect to generate substantial additional excess capital over the next several years.

We are therefore announcing today a new $500 million share repurchase authorization, which will replace our existing authorization. Assuming normal loss experience, we expect to complete at least $300 million of share repurchases by the end of 2013. The precise timing of buybacks will depend on results and market opportunities, but in general we plan to distribute most of comprehensive earnings after dividends, and after setting aside the amounts we expect to need to cover organic growth in risk capital.

The third lever to drive increased returns is via our investment portfolio. As you have heard me say before, we are first and foremost an underwriting-led Company. That said, we have been evaluating various strategies to generate both increased investment income and total returns within acceptable risk parameters. This has resulted in investment of an additional $200 million in equities, and the acceleration of our program to invest in certain higher-yielding credit securities. John will discuss a few of those investments later in the call. We will continue to evaluate other potential investment opportunities that we deem appropriate, given our risk appetite.

In summary, pulling these three levers together means that we expect to continue to improve shareholder returns by increasing both operating ROE and growing book value per share at a high rate. I'm now going to turn the call over to John, and later I'll close with a bit of market commentary.

Chris described our three levers to help increase return on equity. I will take a few moments to discuss each of these levers. Firstly, and as Chris mentioned, since starting on the 1st of November, I have closely reviewed with our management team the expected return and risk profile of our businesses. This has been a thorough analysis, and has led us to the decision to begin a significant and controlled reduction of our catastrophe exposure within our US property insurance account. We estimate that a significant reduction in wind and quake exposure in this account will ultimately free up over $200 million of capital. We will return this newly-released capital to shareholders, unless exceptionally attractive opportunities elsewhere in our business emerge.

The second lever is insuring that the capital we hold is appropriately sized, given the risks in our business. We write business that we expect to be profitable. If we do not believe that sufficient profitable underwriting opportunities are available to employ all of our capital, then we will return this capital to our shareholders. Buying back our equity remains one of the most attractive shorter term value-creating opportunities. To support this, and as Chris mentioned, our Board has authorized a new $500 million share repurchase program. Under the current authorization of $400 million, which we introduced at the end of October 2012, we have already bought back over $40 million of shares, effectively meaning that we will be increasing our planned buyback amount by a further $140 million.

The repurchase of at least $300 million we expect to execute in 2013 will, in part, be funded by existing excess capital. As an approximate statement on how we are managing capital, we would anticipate returning most of our comprehensive earnings after dividends, and after setting aside the amounts that we expect to need to cover organic growth in risk capital.

The third lever is enhancing the returns that we generate from our investment portfolio. We all recognize that the low interest rate environment is likely to remain for at least the immediate future. We have evaluated investment opportunities that will help us to generate increased returns whilst remaining well within our risk tolerances. As a result, we are increasing the total allocation of our investment portfolio to equities and double-B rated securities by $200 million each. We've already completed our additional investment in equities. Our additional investment in double-B securities will predominantly be in bank loans, and we expect to complete this in the medium term.

We're not satisfied with our return on equity, and we're confident that implementing these measures will enhance our operating return on equity beyond the 8.5% we achieved in 2012. As a result of the heightened focus on ROE, we have decided to change the basis of our future guidance. Given the current interest rates and pricing environment, assuming normal loss experience and including a pretax cap load of $190 million per annum, we expect to achieve an ROE of 10% in 2014.

I'll now provide an overview of the results for the quarter and the year, and then I'll move on to discuss capital management. The Group's combined ratio for the fourth quarter was 108%. This included pretax cat losses of $185 million net of reinsurance recoveries and reinstatement premiums. These were principally related to Sandy, and impacted the combined ratio by 36 percentage points. Reserved releases were $42 million, 7.5 percentage points, giving an accident year ex-cat combined ratio of 79.5%. This is an improvement of almost 11 percentage points from Q4 of 2011, reflecting strong underlying margin expansion in both insurance and reinsurance.

Gross written premiums increased 26% from Q4 of 2011. This reflects strong growth in the insurance segment, as well as higher reinstatement premiums related to Sandy and prior year adjustments, primarily in casualty reinsurance. Total operating expenses were $166 million, relatively unchanged from Q4 2011. The acquisition expense ratio decreased 320 basis points to 14.3%, primarily due to a $12 million release of profit commission accruals recorded in prior underwriting periods and an increased level of reinstatement premiums. The general, administrative and corporate expense ratio decreased 80 basis points from Q4 2011 to 15.4%. This decrease largely reflects deductions in performance-based pay accruals.

For the full year, the Group's combined ratio was 94.3%. This included pretax cash losses of $205 million, net of reinsurance recoveries and reinstatement premiums, and reserve releases of $137 million. The accident year ex-cat combined ratio was 90.1%, relatively unchanged from a year ago. Gross written premiums increased 17% compared with the full year 2011. This increase primarily reflects the growth in the insurance segment, as we have continued to build out our US insurance business and have taken advantage of price hardening in some parts of our business. We do not expect any material growth in GWP in 2013.

Total policy acquisition and operating expenses for the year were $726 million, an increase of 15% from a year ago. Whilst the acquisition ratio was largely unchanged, the operating expense ratio increased 1.5 percentage points to 16.6% for the year, largely reflecting an increase in performance-based compensation. Whilst the ratio is in line with our expectations, we are far from complacent about the size of our cost base. Strong control of operating and administrative expenses is very important to us. We will continue to look for opportunities to reduce costs and ensure that the size of our support operations is appropriate for the scale of our business.

Now I will provide some more detail on each of the reinsurance and insurance segments for the fourth quarter and for the full year. The underlying reinsurance business, after adjusting for the effects of Sandy, which impacted the cat-excessive loss of the property and specialty lines in particular, continue to perform strongly in the fourth quarter. The combined ratio of 107.1% included pretax cat losses of $124 million, or 52.1 percentage points, net of reinsurance recoveries and reinstatement premiums. After adjusting for these cat losses, the combined ratio fell to a very favorable 55%, in part due to prior year reserve releases of $38 million, representing 12.6 percentage points. The resulting accident year ex-cat combined ratio of 67.6% was an improvement of 13.5 percentage points compared with Q4 2011.

Gross written premiums of $194 million increased 4% from Q4 2011, largely reflecting higher reinstatement premiums. On the full-year basis, the reinsurance result was underpinned by strong performance across all our lines, with manageable cat losses and steady or improving accident year ex-cat combined ratios. The combined ratio of 85.4% included pretax cat losses of $143 million, net of reinsurance and reinstatements, and prior year reserve releases of $102 million. The accident year ex-cat combined ratio was 78.3%, a 2 percentage point improvement on 2011. Gross written premiums increased 3%, reflecting premium adjustments on prior year contracts. The underlying insurance business, after adjusting to the effects of Sandy, which impacted our US property light insurance line in particular, performed well in the fourth quarter.

The combined ratio of 104.2% for the quarter included pretax cat losses of $61 million, or 15.4% net of reinsurance and reinstatement premiums. After adjusting for these cat losses, the combined ratio fell to 88.8%. Prior year reserve releases were $4 million, or 1.6 percentage points, such that the accident year ex-cat combined ratio was 90.4%, an improvement of 7.6 percentage points compared with Q4 2011. Gross written premiums increased 40% to $382 million, largely reflecting the continued growth of the US insurance business and additional premium in the marine, energy, and transportation business.

The full year insurance result was impacted in particular by the performance of the property and programs lines of businesses, which suffered from increased cat losses in the US. The three other lines, financial and professional, marine, energy, and transportation, and casualty, each posted a significant improvement in their respective net underwritings results compared with 2011.

The combined ratio of 99.3% included pretax cat losses of $63 million net of reinsurance and reinstatements, and prior year reserve releases of $35 million, a $33 million decrease on 2011. The accident year ex-cat combined ratio is 98.9%, a two percentage point adverse movement on 2011, reflecting the impact of Costa Concordia, a non-cat loss. Gross written premiums were 33% higher than 2011, primarily reflecting the growth in the US business. Total annualized investment return for the quarter was 0.9%, compared with 3.5% for 2011. Fixed income book yield for 2012 was 2.9%, down from 3.4% in 2011. This trend is consistent with our expectations, given lower reinvestment rates and declining book yields, and we expect this trend to continue during 2013. Our equity portfolio returned 12.4% for 2012.

In the fourth quarter, we repurchased over 300,000 shares, totaling $10 million, at an average share price of $31.85. So far during 2013, we have repurchased almost one million shares, totaling $32 million, at an average price of $33.23. I will now turn the call back to Chris.

For 2012 as a whole, we achieved average rate increases of 4% on renewals across our entire portfolio, with 5% in reinsurance and 3% in insurance. Currently, the US primary market is achieving the most promising rate increases across a great number of lines. These increases are now beginning to flow through to the reinsurance market. As you know, 1/1 is a very significant renewal date in the market, a renewal period dominated by the US and European markets. For 2012, the US property casualty business achieved a rate increase of 5%. Prior to Sandy, there were initial indications in the market that 1/1 renewals would be flat to down. The loss experience from Sandy reversed that trajectory.

We achieved significant rate increases and loss [experience] to accounts, but accounts with no loss experience were mostly flat. There was a similar trend across most of our properties [treaty] book. For specific lines and geographies where there has been meaningful loss activity, we are seeing significant rate increases. The US property facultative market has [responded] to Sandy with significant increases for flood cover, but fire rates remain flat. The tendency [precedent] to retain more continued during the January renewal period.

In a largely benign year for losses outside the US, rates in international property markets are generally flat, or showing a small decrease. It is encouraging to note that the markets are responding to the Asian cat events for 2011 with event limits being the norm now rather than exception, and markets willing to reduce limits for business interruption and for so-called JIA exposures. For casualty reinsurance for the full year 2012, we achieved a rate increase of 1%. The rate environment continues to vary based on line and geography. The most meaningful rate increases are seen within our US general and professional E&S lines, where we have seen increases of up to 5%. This trend continued in our January renewals.

Overall, we remain cautious about growth opportunities here given the prolonged low interest rate environment. It is, however, also important to note that we do not see any significant changes in loss cost trends for this line, and the rates achieved in our current book are keeping in front of any inflationary indications. There is clearly evidence in our 2012 results which also reflect conservative and prudent reserving. 75% of our reserve releases in reinsurance for the year emanated from short-term classes, with only 25% coming from casualty reinsurance. We are seeing the results of our prudent and conservative reserving, particularly in more recent accident years. It is important to note that the casualty re-releases are from accident years 2008 and prior.

For specialty reinsurance, in 2012 rates declined at 2% on average, with the softest rates being credit and surety reinsurance, following another profitable year. The January renewals produced a mixed story. Marine was dominated by the uncertainty over the Sandy and Costa Concordia losses. Business affected by these events experienced rate increases of up to 30%, with increased client risk retention. Competition and credit maturity is high, with plenty of capacity supplemented by a few new entrants of the market for both primary and reinsurance contract terms and conditions remain disciplined. Now I'll move to the primary market.

As I said earlier, our insurance book for the year 2012 achieved a blended rate increase of 3%. For our property insurance book across both the US and the UK, we achieved an average rate increase of 5%, and the US property achieved an increase of 6%. We saw no major changes in the US property insurance terms and conditions during the most recent quarter, although we are anticipating price increases at midyear renewals in the 5% to 25% range in the loss-affected northeast, and 5% to 10% overall as the market responds to Sandy losses. We're also expect terms and conditions for windstorm and flood to tighten in the northeast.

In our programs business, we achieved rate increases of 3% for the year, and anticipate rates increasing further in response to Sandy losses. In our UK property business, the market remains crowded, but the rating environment appears to have stabilized and we continue to focus on our strict underwriting discipline, which has produced excellent results. We continue to see positive momentum in the US primary casualty market. We achieved average rate increases of 8% for all of 2012, and the outlook continues to be favorable.

The global casualty market is also doing well, with average rate increases of 4% in 2012. In our marine, energy, and transportation business, we achieved an overall rate increase of 2% for the year. This increase was led by the marine, energy, and construction liability account, where the market continues to harden following significant loss activity. Terms remain strong in this account, and we achieved a 9% increase for the year. However, the aviation market remains challenging, with 8% rate reduction for the year. The rating environment in financial and professional lines is mixed, achieving a 1% increase on average. Rate increases were led by the financial institutions account, which was up 7%, and US management liability, up 5%, but rates in the UK remain pressured in areas such as UK management liability and UK professional indemnity.

In summary, we are seeing many of our teams enjoy the benefit of rating tailwinds rather than the headwinds of recent times. In particular, within our insurance segment, we see favorable rating additions and opportunities in marine, energy, and construction liability, in global excess casualty, in US primary casualty, and a perceptibly hardening market in financial institutions, both in the US and internationally, as well as increased deal flow in our credit and political risk team. In our reinsurance segment, we're seeing good rating momentum in marine and US property reinsurance, with an improving market in parts of our casualty business. We're also reaping the benefit of a regional network, where we are achieving favorable rate increases from many international accounts, notwithstanding a tough trading environment in those geographical markets.

Our diversified platform means we're very well placed to take advantage of those areas where rates are improving and leverage our underwriting expertise. This, coupled with the measures we've outlined earlier to enhance our profitability, will enable us to improve ROE and rapidly build shareholder value. We have a very exciting plan, and we are energized about executing it. Thanks for listening to us. John and I would now be pleased to take any questions you may have.

(Operator Instructions)

Amit Kumar, Macquarie.

Just starting with the guidance discussion of 10% ROE, right now the Street estimates are at roughly $3, and I guess if you play with the numerator and denominator, it's still a stretch to get to that 10% number. If I'm doing the math right, what you're saying is that you have $500 million in the buyback, another $140 million is the reduction in exposure, then there is another $250 million which comes from the review, and I guess if you add all of that you get to $900 million. A large part of that is used for buybacks over the next two years, take $600 million to $700 million, a couple of points improvement in loss ratio, and maybe some improvement in investment income from reallocation. Is that the way to think about how you're getting to 10%?

Amit, let me begin to respond there, and them I'm going to hand you over to John for a bit more financial expertise than I'd offer you, but I am afraid you got of couple things wrong, there. We are actually saying, in terms of capital release, from reduced emphasis on catastrophe-exposed US property, we're saying it's a little over $200 million in all, when that program of reduction is complete. Of that, $140 million is actually in the first year.

Okay.

I think you were -- you're adding two numbers where the $140 million is part of the over $200 million.

Got it.

That was probably the biggest thing I heard that was wrong. Now, I think we also said that the $500 million share repurchase program, we're hoping and expecting, given market opportunities [to actually] do, about $300 million of that, maybe a little more than $300 million of that, during this year. So that's probably the line -- the figurative line of capital in 2013. There are some other elements regarding combined rates of investment return that I'm going to ask John to address now.

Amit, in terms of the stretch and reaching 10%, I guess the best way to look at it is the ROE that we've posted for 2012, increasing a bridge between 8.5% and 10%. And what I would say is that a significant part of that is the effects of the share buybacks that we're anticipating. And the full year effects of buying back our current excess capital, I think you can probably work it out for yourself, is about 80 basis points. So the remainder of the movement -- so that half of the remaining 1.5%, really reflects what we anticipate by way of improved operating leverage, offset to an extent, I would say, by a reduction in the expected contribution from investment income. Although as you will have heard, we are taking some steps to mitigate that through investing more amounts in equities and BB-rated securities. Does that help, Amit?

Yes, that does help. Just going back to your comment regarding using Q4 2012 as a bridge, what was the benefit of lower non-cat losses in that number?

Actually, I think our cat load for the year, Amit, is about $190 million, and we've retained cat losses of about $220 million last year. So actually, this is not an exact science. I would say, from a cat point of view, that was as near as you are going to see to a typical year. And another point to look at would be the reserve releases. We, as you know, like to maintain a pretty prudent position here, and for quite awhile now we've been sitting around the 85th, 87th, 88th percentile, after diversification terms of where [this is], we're currently at the end of December lasted, the 87 percentile. That would say to me that the kind of reserve reduction -- releases that we've seen probably represent a pattern that ought continue. Of course, we don't know that, we'll see what we see as loss trends emerge.

So I think, John, in choosing 2012 as a jumping off point is choosing a year that's pretty typical, pretty good, and then, if there was a difference, and John took you through some things there. The other point to put in words, not numbers, is operating leverage is improving. Basically, we have a business that is showing an element of growth. That growth is mainly the result of investments made in the past, so the trend on operating expense ought to be downward, not flat, not upwards. And the lines of business we're talking about are diversifying lines, so they're not consuming incremental capital. Basically the capital, the balance sheet, is going to work harder, and that's why we're not the kind of guys who give you figures lightly. You can be pretty sure if we're saying 10%, that's the kind of number that we mean. And there's a pretty robust case supporting it.

Got it. So just as a last follow-up. Just on the point on reserve releases, you had $138 million in 2012. What you are saying is directionally, even though it might go down, it could be still in the same ballpark, right?

Yes, obviously, there could be no reserve releases. Something in casualty might happen that nobody knows about. But basically, what I'm saying to you is, the reserve strength that we operate at quarter-to-quarter stays unchanged. So the margin of reserves we have over being best estimate is proportionally staying about the same. That said, it should yield the same number of reserve releases, all other things being equal. But there is variability. We are responding to emerging loss trends. So I can't -- it's not a firm prediction. If I knew it was a firm prediction, we wouldn't be carrying the reserves, would we? (laughter) But I think it's a reasonable working assumption.

Okay. That's very helpful. I think that might be also a big delta versus the Street in terms of how much reserve release you are carrying for '13 and '14.

Dan Farrell, Sterne Agee.

Can you talk a little bit more about when you went through the capital review? Can you talk about some of the things that have changed in your thinking? Because it seems like you have looked at some stuff and are taking a different view. I'm not sure if it's capital cushion, or mix stuff that's already happened that had an impact, so could you just go into a little more color into the thinking around that?

Let me try and respond to that. We took the opportunity shortly after I started to do a review of all of our business lines, really with a view to making sure that the risk/reward volatility trade-off looked appropriate. And it wouldn't surprise that you many of those lines looked appropriate, and that's not least because this is an exercise that's going on all the time. But we did feel that there were opportunities for altering the investment that we're making in some lines with review to releasing capital, and using that capital for some share buybacks, or in exceptional circumstances with respect to investing in other businesses. And it's the US property business in particular that we felt that we could use a better use of capital.

But Dan, I'm not sure. Maybe we -- maybe your question is a wee bit more focused on the level of risk capital we need to hold the business? I'm not sure. If it's a little bit more on what we think constitutes [additional] capital, we need to look back into the past. I would have liked us to be buying back quite a few shares in the latter part of last year. We took the view when Sandy happened -- first, we didn't know exactly what it was going to cost us, but we knew more than the Street did, so we stayed out of the market and we missed a couple of months of buying opportunity. Now, if you go back further 2011 to a lot of cat losses, I think we were comfortably but not overcapitalized by the end of 2011. That built up during 2012, and it should have come down in the last quarter, and it didn't come down as much as we want. So we entered this year, as I said earlier, with about $250 million of extra capital. So that's one factor to think about. The second factor to think about is the capital models that underline our business are quite complex. We get them out and kick the tires a bit from time to time, risk committee and board looked at some [actual] work this week at our board meeting. And we concluded that basically, we could safely operate the business with $100 million less capital than we previously felt. So that is another change. So that builds up to a substantial amount of money.

There were, of course, $250 million excess capital starting, and then John talked to you about a gradual freeing-up of capital. That will take -- substantially done in two years, but a bit more to come in year three, there. What else? I think there's a point we're making to you here about the use of earnings. Our business, it's in a really nice position at the moment, because we've got the ability to buy back shares at a price where we think our shares are rather cheap. And that's a nice thing to be able to do. But we've also made investments in US insurance, in reinsurance internationally, and those investments are beginning to yield fruit now. But although the investments are made, they do need a little more capital. So some of those future earnings will be going to fund the growth of the business, and the risk capital that that consumes, but a big part of future earnings are not going to be required to do that. So as John indicated, talking earlier, a substantial part of future earnings will be going to buy back shares. That's beyond the element of excess capital we have already identified. That was rather -- kind of a long answer, but I hope it gets you in the picture.

No, it is, and I recognize you guys have always been very conservative in the way you've approached capital, as well, so I think some of that makes sense. You touched upon another thing I wanted to ask, though, in terms of going forward. I understand the freeing-up of the capital from the mix changes and diversification, getting rid of some of the more risky assets certainly makes sense. You are growing a lot in other lines, so when you are talking about freeing up that capital, that's even net of the gross. So presumably the growth in areas is taking capital, but what you are saying is, I think, is that you are more than offsetting it with mix changes and risk changes to lines that might have more property focus. Is that correct?

Yes. Broadly speaking, right. Where we're withdrawing capital is basically on the primary insurance side from property. Basically, you can get a better return putting that capital into the reinsurance lines for property cat, or by buying back shares. That's the simple equation that's going on. And then I think the broader point is that our business growth is self-funding out of earnings.

Okay. One other very quick question. When you think about capital, do you think of it with the unrealized gains? Your Company -- you have one of the larger differences between cost and market in your book, and I'm just trying to think about if that changes how you think about capital?

Dan, that's right. We do think about capital including unrealized gains.

Okay. Great.

Max Zormelo, Evercore Partners.

The -- my first question, as I think about the reduction in the risk profile, you're taken down [really]quick exposures. First wanted to get a sense for, how you guys are thinking about is ROE, 2014 ROE. I am thinking, why now? And as this actual, why did you decide to do this now, if could you please give a sense of that? And when you think about the wind and quake exposure reductions, are there certain zones you are looking at? I have a couple of follow-ups.

Okay, Max. Let me take that one first. Why now? US primary insurance -- cat exposed insurance -- has been exposed by Hurricane Sandy. And we've got a couple of perspectives on that. One is our own underwriting, and the other is how it's affected the clients whose business we have on the reinsurance side. And reinsurance portfolios have responded in a better way than the insurance portfolios. The flood exposure was under-recognized, under-priced for. The flood zones are out of date. The deductible structure is inadequate. You have political-inspired actions reinterpreting policy forms, such as to increase the losses that need to be paid.

These are issues that fit largely within the primary company's retentions. To some extent, they're going to be found in the reinsurance portfolio, but to a great extent, the reinsurance portfolio, especially where our reinsurance portfolio attaches, is excessive of this use. In other words, that's at the sake of post [plight]. And I think Sandy illustrated that very, very clearly. Also, although there is upward pressure, upward movement in the US primary property with cat exposure, there's also going to be outward movement in reinsurance costs. So I'm not sure that the primary guys aren't caught in a squeeze. They're getting a little more money, but they're having to pay a lot more money to the re-insurers. I think it is the re-insurers in that particular equation are on smarter side. So there's a post-Sandy realization. And I've always said one of things that we like to do in our business is be nimble, be agile, spot an opportunity then take it, or spot an opportunity that's past its prime and get away from it. This is the latter case.

It's not to say all US property is bad. I'm not making that statement. There was some nice E&S property with less a cat exposure, so some areas on the resource side that are very in synch. There's some interesting program business where property casualty package is sold. There's a lot to do, but if it's heavy-duty winds and quake, then we think it's better to sell our capital for a higher price by reinsurance and insurance. I don't really have any guidance to give you on which zones. It is going to be uniform. But if I'm talking about wind, I'm talking about Texas, the Southeast, and even up the Eastern Seaboard to the Northeast, and quake clearly is a West Coast issue. You said you had a couple of follow-ups, Max?

Yes. The second one I wanted to ask about, this is more about looking out to June/July renewals. Given what we've been hearing, so far it looks like you've got a lot of capacity coming in. You've got traditional re-insurers getting aggressive with the market. Want to get your sense for when you look out to immediate renewals, how you see that shaking out? Looking at it, supply and demand dynamics there.

A highly complicated question, Max. As I said on the call, there was a bit more money in US cat. There had been loss -- losses anywhere near it, that would be the Northeast principally. Elsewhere flat. As I look further afield, Asia, there are not a lot of 1/1 in Asia, but it's moved in the right direction, post-all the losses in 2011. Europe, on the other hand, pretty competitive. There's been a long time since there's been a problem in Europe, and I touch wood as I say that, and so there's downward pressure there. So overall, if I look at cat globally, I'm not sure that towards midyear it is getting any better. I don't necessarily see it getting significantly worse. I think our issue is going to be shifting the capital around, those areas that are suffering will be retiring capital from anywhere that offers a bit more price. We'd be putting more capital in.

I think for us, the capital battle is going to be -- clearly, you're right, we do have capital. We could be diverting more to the cat business. But the question is, with our shares trading where we're trading, which is better for us? Which is better for our shareholders? To be putting more capital at risk in the cat business, or to be buying back shares? And that is an equation we keep on review constantly, but at the moment, the flavor of this call suggests that we'll be rather a large capital reduction, but we'll stay pretty relevant in the property cat business. We're not speaking about reducing in the property cat reinsurance side at all. And if it gets a little better, we could even increase. We've got the firepower to do that.

Okay. Last one, if I may. The -- you want to talk about how you see your margins trending next year versus this year? The -- I was looking at the accident year loss ratio ex-cat this quarter versus the prior year quarter improved quite a bit. If you could please tell us how much of that temporary improvement is from non-cat losses, low and non-cat weather losses, and how you expect the margins to trend into 2013 from 2012 levels?

You are right. We do anticipate an improvement in margins over the next year, and that will contribute to an improvement in the overall operating ratio for next year. Much of that is going to come from the insurance line, so writing with [loss] sorts of [things].

No, I think -- I'm just looking more about the overall, the accident year combined ratio ex-cat this year versus how you see that playing out next year. Hello?

Max, I'm not sure we completely understood you. But, if you are asking us to give you loss ratio guidance for 2013 --

Right.

You would understand we'd be a bit reluctant to do that. So we're not -- the guidance we've given is the guidance we've already given on the call.

Okay.

I think what John was saying there is, look, we have addressed business mix. We address business mix all the time, and stuff that ain't making enough money, you either try and fix it or you reduce it or, exception, you close it down. We have just been through a big review of our portfolio, and that makes me believe that the loss ratio it ought to post should be a little bit better. I'm not talking about a lot. I'm talking a percentage point or less, but just marginally better.

Also, as the business grows up, we're not really investing a lot of money the way we were a couple years ago in US insurance, so operating expense also ought to trend down. Put those two things together, and we feel pretty comfortable saying it ought to be a little better in 2013 than it was in 2012. But in terms of further guidance, we don't want to offer that, because we actually believe it's been a little confusing for the market in the past, that we've given too many different metrics by way of guidance.

All right.

Okay, Max. Fine.

Josh Shanker, Deutsche Bank.

I wanted to ask a little bit more about the guidance. You talked about reserves, that you have a conservative approach, so barring any unusual casualty activity, you would expect that we can continue to expect favorable development of this nature. Now, if I talk to other management teams, a lot of discussion has surrounded the fact that frequency and severity of casualty losses has both been far, far better than expected, and that reversion to the mean would cause favorable development to decline for them as well as, I would presume, you. Am I mistaken about that?

Let me start on that. In developing the guidance of 10% ROE for 2014, we felt it was going to be important to give some context around that in terms of cat losses, which is why we say our anticipated pretax cat losses will be in the region of $190 million for the year. Clearly, there is going to be some volatility around that. And as we get to the eventual outturn of ROE, it will vary depending on actual experience, but what we felt it was important to do at this stage was provide a baseline for that number.

I think the other bit of your question, Josh, really was, will there be a reversion to the mean in terms of frequency and severity? Because I think all of us have been surprised by -- for how long claims inflation has been muted, and by the relative absence of really severe pops on the casualty side. I don't know whether there will be a reversion to the mean or not. I guess if there isn't, then it ain't the long-term mean. But things do change. Society does change. There was tort reform a few years ago. There were some things that actually made the business better. It may or may not go back. My central point, though, is as we set our loss reserves, we try to build in a comparable level of prudence every quarter. I think there's a different way of doing reserving which is emphatically not what we do, which I would call, reserve as much as you can afford. So if you get a good quarter, you put a lot of money away, and then you start paying it down until eventually you get to the point where your reserves look a bit skinny. We don't operate the Company in that way.

So I would suggest that, based on all the data, all the knowledge we have by our actuarial team, our loss adjustors, our underwriters, et cetera, we're trying to maintain a comparably prudent position in reserves, which historically gives rise to reserve releases, most all quarters, really. I think all quarters but one in our history. And the most likely thing is that trend will continue. It will continue with some volatility, though. Because loss development can be lumpy.

If there is this reversion to the mean on loss inflation, it would then come through, not in the reserve line, it would come through in the accident year line.

I'm not quite sure what question you're asking to us address.

The point, I would say -- if -- some have said that the reason why there have been so many reserve releases is because the accident frequency and severity have been lower than expected on casualty lines. And you're saying it wouldn't really matter for Aspen, because we're always going to put a cushion on top of what we need. But if there's a reversion to the mean, or let's just say, if accident frequency and severity go up from where they are right now, which seems to be a depressed level, that would be a -- not a reserve problem for Aspen, but there would be a decline in current accident year picks.

Yes. One of the things I did say on the call was, we've reduced our exposure to casualty reinsurance. It's actually down 36% from its peak. We're also constantly picking our spots on the primary side. So I wouldn't -- across the industry, I think your thinking may be right. Across an individual portfolio such as Aspen's, any pickup or return to the mean wouldn't have a uniform impact in us. We're basically not as big in that business, not nearly as big as we once were.

Okay. Appreciate that answer. The other question is, where you're growing in the primary space, what kind of competitors are you taking business from, and why is the business shopping to you?

The principal areas we've grown would be in the US in professional liability, in management liability to a lesser extent, inland marine to a small extent, and surety. We've also written some programs, one program in particular. It's about four years now since we had our first insurance teams in the US. And we said to them, your job is to stay true to your underwriting principles. Go slowly. You will have an adverse expense ratio, but will you continue to offer at the same prices you've always believed it is sensible to offer them. The same products and the same level of service. You have no mission to undercut what you were doing when you worked for another organization. You have no mission to undercut competitors. What will you find is, agents will be disappointed by their carriers because of poor service, poor conduct in claims, or otherwise. And that's going to give you opportunity to quote.

When you quote, you quote technically justifiable prices, and you remind those agents, who are people that you have dealt with before, just how beneficial it is to be with you and your team, and even more so with Aspen capital, Aspen management behind it. And that is what we're doing. So I cannot say there is no company that we're targeting, and price is not the mechanism by which we are moving business. It's service, it's a slow way to do it. That's why we have this adverse expense ratio in our US business. If we had gone faster, there wouldn't have been a expense problem, we might have had a loss ratio problem. As it is, the expense problem will solve itself over time, and the -- we're feeling very good about the underwriting executive pricing discipline and the loss reserve integrity of the account.

I appreciate the answers. I don't know if Julian is on the phone, but I wanted to congratulate him. He's like Michael Corleone. He kept trying to get out and you kept pulling him back in. It's been --

(laughter) I wouldn't liken him to Michael Corleone in any other way, Josh, but I'll pass that on. And if he sends you, whatever it is, a horse's head, you will know why. (laughter)

(Operator Instructions)

Mike Zaremski, Credit Suisse.

Two brief questions. One, have incentive compensation terms been changed in light of the 10% ROE goal? And two, a lot of moving parts within the investment portfolio, so I'm curious where you see the yield migrating to in respect to the 2014 ROE goal?

Okay. I'm going to leave the yield question to John. The statement about 10% is a statement about 2014. We do review our incentive arrangements annually. I think we should. But we tend to do them at the beginning of the year concerned, so we won't be looking at that until 2014. I don't want to anticipate what our compensation committee does but typically, they like to set the bar high, they like to build in some stretch. So if we're saying the performance of the business is a little higher, I think they're likely to say, we need to set the bar a little higher so you don't get over-rewarded. But I don't want to presume what they decide when they meet in February of 2014 to determine those things. Over to John.

(multiple speakers) Is 10% a higher -- is higher than what you guys had previously been expecting for 2014, or lower?

It's up. The whole point of this call, Mike, is really to say, look, 8.5% is a nice result for a year like 2012. We think we can do better. We think there's more profitability within our business model. That's about capital, it's about investment, asset allocation, and it's about underwriting mix. And those are really the things we've been saying. You put those things together, and I think we've actually moved really quite considerably from the aspirations that we would have had if we just done a business as usual thing from six months ago. So yes, it's higher.

Maybe if I pick up the point on investment allocation is that, I think I guided earlier, we're expecting yields on our investment portfolio to come down over time in that thin line with interest rates and the maturity of our book. But an increasing part of the yield and some improvement is going to be through the investments we're making in BB higher risk securities, and also in equities. But I would say, Mike, that the overall investment in equities, BB securities, and other similar securities, is going to be well within our risk appetite, our risk tolerances.

Okay, got it. So the new money yield, I believe, used to be closer to 1%. So are you -- I guess the new money yield won't be as low, base case, as it was in the past. Is that right?

In terms of the new money, I wouldn't say a substantial change from what we've experienced in the recent past.

Okay.

And there are no further questions at this time. I would like to hand the conference back over to the presenters for any closing remarks.

Thank you very much for listening to us ahead of the incoming snowstorm. I hope you all get home safely today. Thanks for listening. Good-bye.

Thank you. This concludes today's conference call. You may now disconnect.